As Drug Payment Model Changes, Confusion Grows Among Insurers

Purchasers are hopeful that life after "average wholesale price" will be simpler, fairer, and, with luck, easier to grasp

Martin Sipkoff

Contributing Editor

Two fairly recent laws and a pending out-of-court settlement will have an effect on how much the government and health plans pay for drugs. The current pricing model is a Rubik's cube of jargon and formulas that artificially inflate costs. Based on so-called average wholesale price, it results in pricing condemned by health plans as arbitrary and excessive.

Drugs move from manufacturer to mouth through wholesalers and pharmacists, and everyone gets a cut. Manufacturers play the biggest role in determining price, but the wholesalers — who purchase drugs in bulk and distribute them to pharmacists — affect final pricing. In paying for brand name drugs, wholesalers generally use AWP (average wholesale price, although some wags insist it means "ain't what's paid").

AWP has never been defined by statute, but it is used by plans and pharmacy benefit managers as the retail list or sticker price for most drugs and as the basis for reimbursement. AWP is widely criticized as not reflecting true market price because it is easily manipulated by wholesalers. The Kaiser Family Foundation details this in a report titled "Follow the Pill."

The emerging model's features are blurry — at least for now — but experts say that once the pieces fall into place, changes will improve clarity and provide greater equity in drug pricing. That's the good news.

The bad news is that health plans are anticipating a daunting adjustment. Two laws — the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA) and Deficit Reduction Act of 2005 (DRA) — have nearly killed the AWP model, and a lawsuit against First DataBank, which publishes AWP, apparently has finished the job.

"We are anticipating imminent changes in pharmaceutical pricing and reimbursement methodologies, and we're all trying to get out on the front edge," says Tim Sawyers, RPh, MBA, director of clinical pharmacy services for the insurer HealthSpring, and editorial board member of this magazine. He said his plan is working to "understand who the stakeholders will be, what system of price determination each of the players will use."

For example, HealthSpring currently participates in Medicare Part D. The company relies on actuarials to determine competitive pricing in the Centers for Medicare & Medicaid Services Part D bid process. The move away from an AWP model will have costly and complicated consequences, says Sawyers. It may require the use of average sales data, a pricing methodology that relies on manufacturers' sales data to set the Medicare payment amount for a particular drug. Plans will have to gather and analyze those data.

"Many pharmacy organizations have formed task forces to evaluate alternatives in preparation for the conversion to another methodology of pharmacy claims processing," he says. "There will be an industry-wide adjustment to whatever the government finally does."

The new system will probably be an improvement. Charges of AWP manipulation led to a 2005 civil lawsuit against First Databank and McKesson, which controls close to 40 percent of the wholesale drug market.

The suit was based on antitrust concerns. It alleged that McKesson colluded with FDB to use pricing ambiguity to inflate prices artificially. Several labor unions charged that McKesson and First DataBank conspired to raise prescription drug prices, with an associated unfair cost of about $7 billion to health plans, private insurers, and state Medicaid offices between 2001 and 2005.

In December, the unions and the plaintiffs reached a settlement that is now being reviewed by a federal district court in Massachusetts. "The settlement is supposed to alleviate much of the current ambiguity in the system," says Tim Kosty, PharmD, president of Pharmacy Healthcare Solutions (PHSI), a consulting company in Pittsburgh.

FDB maintains that it derived its AWP prices by surveying drug wholesalers and manufacturers. AWP is so widely used by wholesalers and retailers as a starting point for setting prescription prices that many purchase lists of the prices from FDB. According to Jeff Hawes, PharmD, a pharmacy benefit consultant for Pharmaceutical Strategies, PBMs frequently use FDB's published AWP list as a benchmark to negotiate drug discounts with pharmacies.

"The recent legal action against FDB may very well be the long-needed impetus to drive appropriate industry changes," says Hawes.

$4 billion in savings

In the proposed settlement, the FDB agreed to scale back the benchmark prices that it publishes. The deal could save consumers more than $4 billion next year alone, according to an analysis by plaintiffs.

The death of AWP actually began about four years ago, when Congress passed the Medicare Prescription Drug Improvement and Modernization Act of 2003 (MMA). In addition to creating Part D, the MMA made adjustments in the way that Medicare pays for many items and services.

"Largely in response to longstanding fraud and abuse concerns related to the AWP pricing methodology, the MMA replaced the AWP methodology with a new pricing scheme based primarily on average sales price," says Diane Ung, a health care lawyer and partner in Foley & Lardner.

The ASP system went into effect Jan. 1, 2005, and Ung says that it has had "a significant impact on pharmaceutical manufacturers, physicians, and suppliers involved in the distribution of covered medications," particularly Part B payments for medications administered in physicians' offices and not available through pharmacies, such as most cancer drugs.

ASP methodology relies on manufacturers' sales data to set the Medicare payment amount for a particular drug. MMA requires pharmaceutical manufacturers to report ASP pricing data to the Centers for Medicare & Medicaid Services (CMS) on a quarterly basis. A significant effect MMA has on general drug pricing is that it makes ASP pricing publicly accessible.

Part D pricing will be primarily affected by the Deficit Reduction Act Under that law, Congress made significant changes to pharmaceutical pricing, Medicaid price rebates, and Medicaid payments to pharmacies. Federal officials predict that the new policies can save $8.4 billion over the next five years.

One reason is that it makes average manufacturer price (AMP), which is used to determine Medicaid rebates, accessible to the public. Previously, AMP was known only to government officials. What's more, the law lowers AMP on many prescription drugs, putting manufacturers under increased cost pressure and increasing Medicaid rebates to states. It also reduces Medicaid payments to pharmacies and eliminates the use of AWP from the Medicaid payment system.

CMS recently published rules for implementing DRA pricing policies. Final rules are expected in June 2007. The law requires significant changes to how manufacturers calculate AMP and what is known as Medicaid best price (BP), which reduces the effectiveness of many pricing concessions used by manufacturers. These include:

Exclusion of prompt-payment discounts to wholesalers,

Exclusion of fewer nominal price arrangements from BP calculation,

Inclusion of what are known as "authorized generics" in calculation of AMP and BP. These are generic drugs manufactured by or under contract to brand name manufacturers, and

Exclusion of drug sales to children's hospitals from BP calculation.

Drug manufacturers were to have begun monthly reporting of AMP in January, and AMP on all drugs will be publicly posted on CMS's Web site starting Spring 2007. Past reporting was confidential.

Significant change coming

"Though there are several competitors for the next generation of pharmacy pricing benchmarks, there does not appear to be a clear drug-pricing alternative that will solve all of the problems," says Hawes.

But at the least, all the current changes — MMA, DRA, and the problems faced by FDB — mean that plans must get ready for significant change, says Kosty. "Plans want an equitable system," he says. "It's not known what impact all this will have, but we do hope it will be an improvement."

Pricing terms

Average Manufacturer Price (AMP): The average price paid to a manufacturer by wholesalers for drugs distributed to retail pharmacies.

Average Sales Price (ASP): The weighted average of all non-federal sales to wholesalers net of chargebacks, discounts, rebates, and other benefits tied to the purchase of the drug product, whether it is paid to the wholesaler or the retailer. The basis for payment for products covered under Medicare Part B changed under the Medicare Modernization Act of 2003 from AWP to ASP.

Average Wholesale Price (AWP): Although not defined in statute, AWP is recognized as retail list price (sometimes referred to as a sticker price) and is currently used by some public and private third-party payers as the basis for payment (e.g., AWP minus 25 percent).

Estimated Acquisition Cost (EAC): EAC is a state Medicaid agency's estimate of the price generally paid by pharmacies for a particular drug.

Maximum Allowable Cost (MAC): MAC lists are designed to cap payment for certain generic and multisource brand products. States and private payers with MAC programs typically publish lists of selected generic and multisource brand drugs along with the maximum price the program will pay for those drugs. In general, pharmacies will receive payment no higher than the MAC price when billing for drugs on a MAC list.

Wholesale Acquisition Cost (WAC): The price paid by a wholesaler for drugs purchased from the wholesaler's supplier, typically the manufacturer. Publicly disclosed or listed WAC amounts may not reflect all available discounts.

Source: Adapted from Follow the Pill: Understanding the U.S. Commercial Pharmaceutical Supply Chain. Kaiser Family Foundation. March 2005.

How are we paying for drugs now?

Health plans are drug purchasers because they reimburse their customers for medication expenses. Very few plans still deal with pharmacies on a fee-for-service basis. Most either outsource management to a pharmacy benefit manager, operate their own PBM, or outsource claim administration only. Regardless of the strategy, plans influence cost containment by negotiating restrictive formularies with payers and by creating competitive pharmacy networks through negotiations with drug store chains.

Pharmacy benefit managers are also purchasers, of course, and they use a variety of ways to control their drug costs: formularies, rebates negotiated with manufacturers, pharmacy networks, mail-order services, claim adjudication, mandatory generic substitution, and even disease management programs.

Large employers that are self-insured generally negotiate contracts with PBMs, and occasionally specialty pharmacies. Employers exercise control over the supply chain through the contracts they set with PBMs, which govern:

The prices of pharmaceuticals paid by the employer,

The cost sharing by the insured population,

The type of formularies that will be applied,

The network standard for pharmacies, and

What types of drug utilization review will be applied.

Employers pay PBMs on an administrative services basis and/or by allowing the PBMs to retain a portion of manufacturer rebates.

Under Medicaid, federal law requires that states pay for brand name prescription drugs based on whichever is lower between:

The estimated acquisition cost (EAC) of a drug (the method most states use); or

The usual or customary charge to the public.

Most Medicaid programs use a drug's AWP to calculate the EAC, generally AWP minus some percentage.

An additional limit, known as the Federal Upper Limit (FUL), applies to the purchase of generic drugs. Manufacturers that want to have their drugs covered by Medicaid must provide rebates to state Medicaid programs. And there is the Maximum Allowable Cost (MAC), which is a cap set by payers on payments for certain generic and multisource brand products. States and private payers with MAC programs typically publish lists of selected generic and multisource brand drugs along with the maximum price the program will pay for those drugs.

In general, pharmacies will receive payment no higher than the MAC price when billing for drugs on a MAC list.

The Medicaid Best Price is the lowest price paid to a manufacturer for a brand name drug, taking into account rebates, chargebacks, discounts, or other pricing adjustments, excluding nominal prices. (Wholesalers "charge back" manufacturers for any difference between the negotiated prices paid by the customer and the wholesaler's cost of goods. This "chargeback" system allows buyers who have negotiated different sets of prices with manufacturers to take advantage of the efficiencies in distribution offered by wholesalers.)

Medicaid best price is used in the Medicaid rebate statute to calculate manufacturer rebates owed to state Medicaid agencies.

Prices charged to certain governmental purchasers are statutorily excluded from best price, including prices charged to the Veterans Administration, Department of Defense, Indian tribes, the Federal Supply Schedule, State Pharmaceutical Assistance Programs, Medicaid, Public Health Service "340B" entities, and Medicare Part D prescription drug plans (starting last year). Best price data are reported by manufacturers to CMS, but are not publicly available.

It is this complicated formulation that will soon change, say health plan officials, as the result of the FDB-McKesson lawsuit settlement and CMS rule changes under DRA 2005.

"Those changes will have a profound effect on the industry," says Tim Kosty, PharmD, president of Pharmacy Healthcare Solutions, a consulting company.

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